Company liquidations and entrepreneur's relief
On 24 March, HMRC published a summary of responses to the December consultation on Company Distributions, together with details of the Government's position on the issues raised. The December consultation was covered in my 3 February blog.
Not much has changed following the consultation. The Government is pressing ahead with its proposed changes, in much the same form as originally trailed. Anyone thinking of liquidating a company or of using SPV companies for particular projects, which may subsequently be liquidated when the project ends, should focus on the proposed changes. It is unlikely to matter whether the company is a UK company or an overseas company. The new rules will come into effect in April this year. They represent another tax trap for the unwary.
To recap, the Government is concerned that companies are being liquidated in connection with arrangements designed to extract profits in capital form rather than as dividend income. The top rate of CGT is currently 28% (due to become 20% generally, per the Budget), while entrepreneur's relief can bring that down to 10%. By contrast, the additional rate of income tax is 45% and of dividend income tax is set to be 38.1%. The Government does not want taxpayers to structure a capital return where the reason for doing so is "mainly to benefit from lower tax rates".
There were two proposals: first, tightening up the existing "Transactions in Securities Rules", and secondly introducing a new "Targeted Anti-avoidance Rule" (or TAAR). Most of the responses to the consultation addressed the second proposal.
Broadly, under the TAAR (as refined following the consultation), it is proposed that a distribution on a winding up should be taxed as an income distribution where:
(A) immediately before the winding up, the individual has at least a 5% interest in the company;
(B) the company is a close company (or was a close company at any time in the two years ending with the start of the winding up);
(C) within 2 years after the distribution, he/she (or someone connected with him/her) continues to be involved (directly or indirectly) in the same or similar trade or activity (it needn’t be through a new company, it could be individually or through a partnership etc); and
(D) having regard to all the circumstances (including limb (C)), it is reasonable to assume that the arrangements have a main purpose, or one of the main purposes of obtaining a tax advantage.
There is concern that the TAAR could undermine commercial transactions. For example, currently a business can be sold by a sale of the company carrying on the business, or by the company selling its assets and then being liquidated in order for the shareholders to extract the purchase price. The TAAR could affect the second route, albeit that it is commercially motivated - for example, will shareholders be concerned that limb (D) above will not be applied? What, also, about SPVs - if I sell the assets of a project, I can expect a capital return, but if I run the project through an SPV (for good non-tax reasons) then sell the assets and liquidate the SPV, I may be at risk of a materially different tax outcome. A further example is that entrepreneurs may be discouraged from making serial investments in any given sector or field, for fear of falling within the new rules such that their return is treated as income for tax purposes rather than capital benefiting from entrepreneur's relief. The underlying point here is that a lot is likely to rest on limb (D), and HMRC's approach to it, because a lot of genuine commercial activity may fall within limbs (A) to (C). Limb D is a "reasonable to assume" test, which technically is not quite the same as testing the actual intention of the parties (although in many cases the outcome will be the same).
The Government's response is:
"...the government would stress that it would still expect the vast majority of distributions from a winding-up to be treated as capital (as is currently the case). The government will amend the draft legislation so that:
- it will not apply to minority shareholders;
- 'arrangements' [in Limb (D)] is clearly defined;
- distributions will not be treated as income to the extent that they represent the Capital Gains 'base cost'; and
- the exemption for distributions of irredeemable shares will be widened to ensure that the TAAR does not apply to standard 'liquidation demergers'"
There will be other changes re: partnerships and holding companies.
Whilst welcome, these are tweaks at the margins, and the risk of uncertainty remains. HMRC will publish guidance on the new rules with examples of innocent transactions. These will be key. It is unfortunate that the meaning of well-intentioned legislation, in practice, will have to be determined by reference to examples in published guidance. The examples will need careful thought and should be based on real world commonly encountered transactions.
Unfortunately, the Government does not believe that a clearance procedure is appropriate.
The Government confirms that it does not intend, for now, to make any further changes to the tax treatment of company distributions.
Like all such changes, the new rules (which have a sensible policy aim) will no doubt bed down and a good understanding of HMRC's position will develop, but in the meantime, there may be genuine uncertainty for genuine commercial transactions.